Gifting stock in a closely held business is often a good technique to transfer assets out of someone’s estate if they are concerned it will be subject to estate taxes in the future.
Gifting, when the value of the stock is at a low, maximizes the benefit of gifting. Future uncertainty causes stock values to decrease, so now is a great time to consider a gifting plan!
1. COVID-19 means there’s never been a better time to keep company growth out of your estate
When your estate gets close to taxable estate limits, a good tax-planning strategy is to keep the growth of your business out of your estate — and thus reduce estate taxes. Any growth in your company’s value after the date of the gift stays out of your estate.
For example, you gift your company to your adult child(ren) in 2020 when it is worth $5 million, and it grows to $15 million at the time of your death. Even though the company value of $15 million is above the lifetime gift exemption of $11.58 million, there is no taxable value included in your estate. You only use $5 million of that lifetime exemption.
Gifting to your child(ren) right now is especially ideal because the COVID-19 pandemic has driven down the value of many companies. And it’s done so in four different ways:
- Businesses are seeing lower actual or projected revenue due to the pandemic’s impact, which drives down value.
- Businesses have increased their interest-bearing debt in order to pay employees and other fixed expenses, and debt reduces a company’s value.
- Businesses have seen a decrease in the value of tangible assets such as inventory, machinery, equipment and real property due to changes in market demand and occupancy rates.
- Businesses have seen value decrease because of lack of control and lack of marketability discounts due to liquidity issues in the market.
By gifting when your business’s value is lower, you gain three benefits. One, you will use less of your total estate exemption, and that will allow you to transfer other assets without tax implications. Two, you can gift a lot more of your business without tax impact. And three, the COVID-19 pandemic is not going to last forever, and business values will rebound, so by gifting now, you keep this value appreciation out of your estate.
2. The upcoming U.S. election could mean changes to the lifetime exemption
When you gift interest in your company, you currently do not have to pay taxes on the gift until the total value of the gift(s) is over $11.58 million. If you are married, you can gift up to $23.16 million before you have to pay taxes, if no other gifts have been made.
So why is now the best time to max out your gifts to the current limit? Because the upcoming U.S. election is bringing a lot of uncertainty with it.
Under current U.S. tax laws, the lifetime gift exemption of $11.58 million is set to decrease in 2026. Given how low tax rates are and how high exemptions are right now, we’re almost guaranteed to see this change by either political party — and it could happen at any time. By acting now, you can take advantage of low tax rates and high exemptions while you still can.
It’s also important to be aware that Congress and future presidents could limit the discounting strategy we discuss below in section #4. A proposed IRC 2704 regulation would have limited discounting options, but it was stopped with the 2016 change in U.S. presidents. The idea of limiting discounting could arise again after this year’s election. This is yet another reason to act now while things are still certain.
3. The annual gift tax exemption is $15,000 per person and doesn’t count toward your lifetime exemption
As of 2020, you can give up to $15,000 per year to one or more people. If you are married, you and your spouse can give a combined $30,000 to each individual. Best of all, annual gifts that qualify under this gift-tax exclusion do not reduce the lifetime estate or gift tax exemptions.
For example, parents with four children could transfer interest in their business that totals $120,000 ($30,000 X 4) this year without reducing the $11.58 million lifetime exemption. With the discounting discussed in section #4 below, the $120,000 represents a much larger value to the children. For example, at a 30% discount rate, the $120,000 will really represent $185,714 rounded ($130,000/70%).
The disadvantage of gifting the annual exemption amount each year is that you still have the growth of the business in your estate for the percentage you own. But if your company value is small, this may be a good approach to consider.
4. The discounts for lack of control and lack of marketability let you transfer more assets out of your estate
When a privately held company is sold or gifted, the value of the company may be reduced by the lack of control and lack of marketability discounts. These discounts are due to 1) the inability of a minority shareholder to sell their stock and 2) the lower price someone would pay for that stock if they don’t have control of the business.
With these discounts, you can transfer more stock to your child(ren) under the gifting limits and get more of your assets out of your estate. It is better to transfer a minority interest in a company than to transfer undiscounted cash.
Discounts for lack of control and marketability are dependent on many variables but can range from 10% to 25% each.
Take advantage of the discount for lack of control and discount for lack of marketability, plus the annual donee exclusion, with your spouse to save sizable estate and gift taxes.
How Wipfli can help
Right now, you have the opportunity to transfer part of your family wealth when business values are down and tax exemptions are high. Once the impact of the COVID-19 pandemic comes to an end and the economy begins to improve more and more, company values will increase. Give one of Wipfli’s Business Valuation professionals a call today to discuss whether now is a good time to look at gifting stock in your closely held company. Click here to learn more about our valuation services.